These forecasts and their realization, only a day later, teach us once more that hindsight is much clearer than foresight. Psychologist Baruch Fischhoff wrote, “In hindsight, people consistently exaggerate what could have been anticipated in foresight… People believe that others should have been able to anticipate events much better than was actually the case. They even misremember their own predictions so as to exaggerate in hindsight what they knew in foresight.”2

Good hindsight shortcuts lead us to repeat actions that brought good outcomes and avoid actions that brought bad ones. Hindsight shortcuts can turn into hindsight errors, however, where randomness and luck are prominent, loosening associations between past events and future events and between actions and outcomes.

Fast driving when luck is good gets us faster to our destination, but fast driving when luck is bad gets us a speeding ticket or worse. Hindsight errors can mislead lucky drivers into thinking that fast driving always gets them to their destinations more quickly, and can mislead unlucky drivers into thinking that fast driving always gets them a speeding ticket. Hindsight errors also can mislead lucky traders into thinking that fast trading always gets them to their profit destinations more quickly, and can mislead unlucky traders into thinking that fast trading always inflicts losses.

We protect ourselves against hindsight errors by the steady holding of diversified portfolios…our way of accepting, wisely, that our investment foresight is not as good as our hindsight, and that we should keep our eyes firmly on our financial and life goals.

Meir Statman

Meir Statman is the Glenn Klimek Professor of Finance at the Leavey School of Business, Santa Clara University, and a member of Loring Ward’s Investment Committee. His research focuses on how investors and managers make financial decisions and how these decisions are reflected in financial markets.